Canada's stock market is pulling ahead. Here's what investors should know and how to play it

Published Fri, Apr 1 202210:37 AM EDT

U.S. investors have reason to envious of their northern neighbors after the first three months of 2022, but there may still be ways for Americans to benefit from a strong year for Canadian stocks. The Canada S & P/TSX Composite rose 3.1% in the first quarter when measured in local currency, and 4.3% in terms of U.S. dollars. That performance puts Canada's market well ahead of U.S. and European peers. Jefferies global equity strategist Sean Darby called the country's market the "lone survivor" of 2022 in a note on March 24. "The Canadian bourse is one of the few in positive territory YTD, while the currency has been supported by a positive terms of trade," the note said. "The equity market is in fair value territory based on our valuation metrics, while earnings revisions have held up well. Robust economic growth gives the central bank room to lift rates and to do quantitative tightening. We remain Modestly Bullish." Michael LaBella, a portfolio manager at Franklin Templeton Investment Solutions, said that the composition of the Canadian stock market made it well prepared for the current macro environment. "Canada's really benefiting from a couple of key things. One is there is significant exposure to commodities businesses in Canada, so it is definitely benefiting from the inflationary backdrop that we've seen in markets," LaBella said. Roughly 65% of the Canadian market is energy, materials and bank stocks, LaBella said. The market also has a relatively high dividend yield, another attractive feature for investors looking to manage volatility and inflation. Additionally, Canadian stocks can get a boost from strong U.S. growth. "Canadian equities are trading at a much better valuation that U.S. equities, so it is seen as a favorable place to participate off of U.S. growth," LaBella said. How to play it There are several easy ways for U.S. investors to get exposure to the Canadian market. There are several Canada-focused exchange traded funds that track the broader market. In the first quarter, the iShares MSCI Canada ETF rose 4.6%, for example. There are also some Canadian stocks that trade in the U.S. Bank of Montreal and Toronto-Dominion Bank both trade in New York and gained 9.5% and 3.6%, respectively, in the first quarter. Canadian Natural Resources jumped more than 46%. Additionally, there are some international-focused ETFs and mutual funds that are not Canada specific but have large exposure to the country. For example, LaBella manages the Legg Mason International Low Volatility High Dividend ETF , which had more than 12% weight in Canada during the first quarter and rose 1.7%. However, that fund and many other active funds rebalance quarterly, so investors should monitor their holdings to make sure they are still getting the exposures they want. Reasons for caution Ed Moya, senior market analyst at Oanda, said that the country's exposure to natural resources have served it well, especially given the conflict in Europe, but cautioned that an aggressive path from the country's central bank could limit upside going forward. The Bank of Canada hiked its benchmark rate on March 2 and signaled that more tightening was coming. Moya said he expected the central bank to be "extremely aggressive" in fighting inflation. However, the Canadian banks could benefit from rising rates, LaBella said. Another area for investors to be cautious is Canadian companies with high exposure to other economies. For example, Shopify is headquartered in Canada, but more than half of its revenue in 2021 came from the United States. -CNBC's Michael Bloom contributed to this report.

Andre De Grasse of Canada celebrates with his national flag after winning gold at Olympic Stadium, Tokyo, Japan, August 4, 2021.

Phil Noble | Reuters

U.S. investors have reason to envious of their northern neighbors after the first three months of 2022, but there may still be ways for Americans to benefit from a strong year for Canadian stocks.